Choosing Size of Government Under Ambiguity: Infrastructure Spending and Income Taxation (WP-12-16)

IPR-WP-12-16

Charles F. Manski

Attempting to shed light on the optimal size of government, economists have analyzed planning problems that specify a set of feasible taxation-spending policies and a social welfare function. The analysis characterizes the optimal policy choice of a planner who knows the welfare achieved by each policy. This paper examines choice of size of government by a planner who has partial knowledge of population preferences and the productivity of spending. This is a problem of decision making under ambiguity. Focusing on income-tax-financed public spending for infrastructure that aims to enhance productivity, Manski examines scenarios where the planner observes the outcome of a status quo policy and uses various decision criteria (i.e., expected welfare, maximin, Hurwicz, minimax-regret) to choose policy. The analysis shows that the planner can reasonably choose a wide range of spending levels—thus, a society can rationalize having a small or large government. He concludes that to achieve credible conclusions about the desirable size of government, researchers need to vastly improve current knowledge of population preferences and the productivity of public spending.